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SHAK Short Squeeze

One of the stocks I am shorting, Shake Shack (SHAK) is now in a short squeeze situation. Let me explain what these terms mean:

When you short sell a stock, you borrow shares of that stock from your broker and sell them in the open market. In effect, you are betting that the stock will go down and you will make money. For example, I short sold SHAK at $74 per share. This means that I borrowed the shares of this stock from my broker and then sold them in the market. My broker puts the proceeds from that sale in my trading account. My hope was and is that this stock goes down, unfortunately it has gone up to $83 per share, which means that I am losing money at this point in time.

Why do I think SHAK will go down? It’s a fast casual dining restaurant with only a few locations that is trading at a $3 billion market cap. That means each location is currently valued at $40+ million! For comparison, Jack in the Box location are valued at around $1.2 million each currently. I think the underlying company is run by a very smart guy, Danny Meier, who knows the food business and will do well in the long run. At this point though, the stock is probably 5-10x overpriced for what it is. When bad news comes out, the stock price will probably drop significantly.

Now, for the most important question: what is a short squeeze?

A short squeeze is when people who have short sold a stock are forced by their broker to close their position by buying it back. For example, if SHAK goes to $300 per share, my broker would buy shares on my behalf at that point to close my position. I would lose a LOT of money if that happened. Essentially I sold the stock already for $74 per share, and now I have to go into the open market to buy it back at $300 per share. This would be a $300 – $74 = $226 per share loss. As I have shorted many shares, this would be very painful. Fortunately, I took only a small position relative to my total portfolio, so I am not much at risk here.

Other people though probably were not so cautious and there is currently a nasty short squeeze going on in SHAK. A lot of people may have put 30-50% of their portfolio in short selling SHAK when it was only priced at $40-60 per share. Now that it has gone all the way up to $82, their brokers are forcing them to buy the stock back at huge losses. Since they are force to buy, this drives the stock even higher – meaning that more and more short sellers are being forced to buy the stock. This creates a vicious cycle where the very people who hate the stock most (the short sellers) are forced to buy it and push the price higher!

Shake Shack (SHAK) is up 8% today alone with no news… my opinion is that there is a nasty short squeeze at work forcing people who don’t want to buy the stock to buy it.

The short squeeze should end at the end of the IPO lockout period on July 29th… the theory is all the original investors will want to sell at such a high valuation and flood the market with more shares, driving the price back down to somewhere around $40-60. The question is, can the short sellers survive the squeeze and make it till July 29th?

I can definitely survive the squeeze, but I will probably take a loss on this stock anyways because I forgot that I have to pay interest on the stock that I borrowed from my broker. Usually this is not a big deal as most stocks only cost 1-3% a year to borrow. I did not think to check SHAK’s rebate rate though ahead of time and it is actually charging between 110-130% annual interest right now! Which means that I will have to pay 30% interest just to make it to July 29th. The stock will need to drop all the way to around $56 for me to break even on it.

I wonder how many people out there short sold it at $50 per share and are now feeling the full effects of the short squeeze?